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Why should the government buy toxic assets?

The current idea is to establish an "Aggregator Bank" that will munch up the mortgage-backed securities that banks can't, or won't, sell. This is, of course, the original and much-maligned purpose of TARP. Skeptics abound. Here's Paul Krugman:

Financial institutions that want to "get bad assets off their balance sheets" can do that any time they like, by writing those assets down to zero — or by selling them at whatever price they can. If we create a new institution to take over those assets, the $700 billion question is, at what price? And I still haven't seen anything that explains how the price will be determined.

I suspect, though I'm not certain, that policymakers are once more coming around to the view that mortgage-backed securities are being systematically underpriced. But do we really know this? And how are we going to ensure that this doesn't end up being a huge giveaway to financial firms?

The problem is not that MBS's are hard to value; they shouldn't be harder to value than anything else. After all, people don't seem to have much trouble valuing the institutions—the banks, for example—that own them, whose shares they trade, albeit at much reduced price these days; so why should they have trouble valuing the assets these institutions own? The problem is not one of difficulty of valuation, but of the incentives of the banks. Banks apparently hold onto their MBS's because they would become insolvent or violate minimum capital adequacy requirements if they traded them for paltry sums of cash and/or marked them down to the market value that would be revealed as a result of trading. In the meantime, the banks can hope that the securities will appreciate either because the economy improves or the government intervenes.

If all this is true, the Aggregator Bank will be able to buy up the MBS's only by "overpaying" for them in the sense of paying more than the expected value of the stream of payments to which the holder is entitled—which the market says is lower than the banks claim. The Aggregator Bank has to pay the banks a premium that will reflect the loss of option value for the shareholders—whose shares would otherwise be worth zero rather than the value of the upside that would come with an economic recovery or other positive change in circumstances. This need not involve enriching bank shareholders, as Krugman suggests, though it could if done poorly—if the Aggregator over-overpays.

What is gained by this exercise? Not increased certainty or the discovery of the "real" value of the MBS's. It would have to be—if the intervention were to make sense at all—that the MBS's are worth more aggregated in the hands of the Aggregator than they are in the hands of banks and other investors scattered around the world. How could this be the case?

To see how, consider some of the litigation that has erupted as a consequence of the subprime crisis. This excellent blog, by Isaac Gradman, provides some examples. Debtors and attorneys general are suing loan originators like Countrywide for predatory lending practices, and winning settlements. Under the terms of these settlements, the mortgage loans are modified, with principal and interest reduced. The problem is that Countrywide is now the loan servicer for these loans, so if it agrees to lower payments, as it has, the holders of MBS's, not Countrywide, incur the loss. Can it do this? A definite maybe! Everything depends on the terms of the contracts between the loan servicer and the MBS holders. The contracts usually say that the loan servicer has to repurchase securities if the underlying loan was predatory, but there appears to be plenty of ambiguity, and indeed Countrywide's own obligations under the settlement seem to be contingent on its contracts with the investors. And even when predatory lending is not in issue, it is often in everyone's interests to renegotiate a mortgage loan when the debtor would otherwise default—because the house typically loses fifty percent of its value in foreclosure and would be worth more if the debtor gets to keep it.

But for every loan that has to be renegotiated, there are hundreds or thousands of investors who own securities that share in the proceeds of the loan, and each one of those investors—or a coalition of them if, as I suspect, the contract provides for a voting system—has the de facto right to block the loan renegotiation if they object to it. Even if, in the end, they lose, for the time being they can litigate, and little will happen until all the underlying legal issues are resolved. This creates a massive collective action problem, akin to corporate insolvency, the reason why we have bankruptcy law in the first place. The difference is—and this is crucial—that in your average corporate bankruptcy, where you have thousands of creditors and shareholders and other interested parties, millions or billions of dollars worth of assets will be at stake. Bankruptcy judges can twist arms, ensuring that too much value is not lost while parties squabble. Here, we again have thousands of interested parties, all with de facto "votes," but now all that is at stake is one person's home. MBS holders might, in theory, gain if loans are renegotiated but probably believe that since they can't, as a practical matter, guard their interests in millions of separate loan renegotiations, they do best by blocking all of them—especially in the current political climate that sympathizes with homeowners. It is hard to imagine a more inefficient system.

Two bills try to address this problem. A bankruptcy reform bill would enable bankruptcy judges to cram down mortgage loans in Chapter 13. MBS holders simply would have no way to block loan renegotiations that reduce the value of their securities. This is not necessarily a bad idea, but bankruptcy is always slow and costly.

Barney Frank's TARP-2 bill would require loan servicers and holders of mortgage-backed securities to revise the terms of their contracts. As Steven Davidoff describes it:

Significantly, the bill also abrogates the mortgage-backed security service agreements between servicers and investors in M.B.S.'s. Many of these agreements had required that in the case of a loan modification, the servicer was required to repurchase the loan. Instead, the bill voids these privately negotiated contractual provisions and allows these servicers to freely modify these loans if (i) the property is owner-occupied; (ii) default has occurred or is reasonably foreseeable and (iii) the servicer reasonably believes in good faith that the recovery on the principal obligation of the remodification will exceed the anticipated recovery on a foreclosure on a net present value basis.

This provision isn't as crazy as Davidoff thinks it is. If (iii) is really correct, and if individual MBS holders might hold out for a better deal rather than consent to loan modifications under the terms of the contract, then the bill solves the collective action problem. The difficulty is that all of these mushy words ("reasonably foreseeable," "good faith") have uncertain meaning, and can be exploited by the servicer to pummel the MBS holders. Servicers will do so to keep the TARP funds coming, though I hope the government realizes that as the price of MBS's fall, the government will have to send even more funds into the banks that own them, unless of course the whole crazy scheme works and the price of MBS's rises because of the reduced risk of hold-out.

Anyway, the Aggregator is an improvement on this scheme. Instead of trusting servicers to renegotiate wisely with debtors, with servicers acting as agents for unhappy MBS holders, the government steps into the shoes of the MBS holders and dictates the new terms of the mortgages. The theory behind the Aggregator must be that if the government owns all (or, anyway, enough) of the MBS's, then any remaining private MBS holders cannot hold out in negotiations to modify loans. No need to force loan servicers and MBS holders to renegotiate and no more litigation between loan servicers and MBS holders. As the primary owner of MBS's, the government will voluntarily ease the mortgages simply by waiving or relaxing its own contract rights. The theory here is not the TARP-1 view that if the government starts buying, the MBS market will be jerked back to life; it is that the government will break logjams caused by the dispersion of control rights among zillions of investors. Life is so much easier when the government owns everything.

To sum up, it's not that MBS's are being "systematically underpriced," in Krugman's words. It is that they are worth more together than apart, and only the government is big enough to own all (or enough) of them. That, anyway, is the only way I can make sense of the various reform proposals. If someone has a better theory, I am all ears.

Tracy Johnson (www):
I don't see the problem, the EPA has been cleaning up toxic sites for years ...
1.19.2009 10:19am
Tracy Johnson (www):
Using the "superfund" no less.
1.19.2009 10:20am
Michael F. Martin (mail) (www):
The problem is that nobody wants to to first and lose their shirt after the government steps in (either with the entity invested in or its chief competitors).
1.19.2009 10:27am
Charlie (Colorado) (mail):
Jeez, I was all set for this to be another piece that runs out ideological reasons why it is or isn't a good idea, and you went and made sense. What kind of blogging is that?

Anyway, yeah. Put conscisely, the real problem with the MBS's is that for a whole host of reasons, some having to do with their complexity and a whole lot of them having to do with uncertainty about how people and government are going to respond, the value of the MBS's is uncertain. This makes the market in them illiquid, and means that risk-averse investors will only buy at a steep discount.

The FAS 157 "mark to market" rule means that these very low prices make the MBS's a drag on the balance sheet far beyond whatever real loss in value they may have suffered.

The "bad bank" would buy them up, yes at a premium to the current market, but with some confidence that when an orderly market can discover realistic prices, they'll be worth more than the current panic value. At the same time, they come off bank's books, meaning the banks aren't being driven into artificial insolvency.

And the reason the government needs to do it is basically a demonstration of the Pottery Barn Law: you broke it, you bought it.
1.19.2009 10:30am
David Schwartz (mail):
The government didn't break these mortgages. These mortgages are broken because originators made loans to people who couldn't pay them off. The current owners of these securities, who likely bought them at a massive discount from the actual victims, will get a windfall.

And the reason they are now illiquid has little to do with trouble estimating their value. It has to do with the fact that everyone is expecting the government to overpay for them in the future, so why sell them now for a fair price?
1.19.2009 10:48am
Bruce Hayden (mail) (www):
I like that: the Pottery Barn Law, esp. here.

Even with this explanation, I am still troubled by the ability of the banks to get stuff off their balance sheet that they really should be taking responsibility for. So, if it really is a liquidity problem, I would hope that there were some way that the feds could get back any underage when the loans are finally done.
1.19.2009 10:52am
cognitis:
"Aggregator" bank would just take money from taxpayers and give it to owners of bank bond holders.
1.19.2009 10:57am
gran habano:
"artificial insolvency"

That's a good one, Charlie, I need to write that down.

I shoulda thought of that years ago, when I was foolish enough to think a business was insolvent when it ran out of money.

That isn't the taxpayer's pottery lying there broken, btw, but rather it belongs to Paulson's buddies, or at least it will until the taxpayer's pay them an inflated price for it.
1.19.2009 11:03am
Wmkt of Decatur (mail):
Too bad Frank and other members of Congress who have been dead set on sticking the taxpayers with a portfolio of swill have not come up with legislation to force bank execs, Treasury higher-ups, the Fed, and the congressional pension fund to put in their cash instead of ours to sop up the TARP market.
1.19.2009 11:07am
NTB24601:
Eric Posner:

The problem is not one of difficulty of valuation, but of the incentives of the banks. ....

If all this is true, the Aggregator Bank will be able to buy up the MBS's only by "overpaying" for them in the sense of paying more than the expected value of the stream of payments to which the holder is entitled—which the market says is lower than the banks claim. The Aggregator Bank has to pay the banks a premium that will reflect the loss of option value for the shareholders—whose shares would otherwise be worth zero rather than the value of the upside that would come with an economic recovery or other positive change in circumstances.


I'm confused by the reasoning that leads to the conclusion that this is not a valuation problem. It sounds to me like Professor Posner is saying that the calculated value needs to be the current market value plus some uncertain "premium" to reflect the lost option value. Assuming arguendo that reasoning is correct, aren't we left with the problem of valuing that premium? So isn't it still a valuation problem?

In my first reading, I thought the reasoning was going to be that if the bank incentive problem is solved then the valuation problem would disappear because the market could then be used to value the MBS's. That doesn't appear to be the reasoning though.


The problem is not one of difficulty of valuation, but of the incentives of the banks. Banks apparently hold onto their MBS's because they would become insolvent or violate minimum capital adequacy requirements if they traded them for paltry sums of cash and/or marked them down to the market value that would be revealed as a result of trading.

Isn't this the problem that the Treasury tried to solve by using the TARP to inject capital? If so, why can't the market now be used to value the MBS's?
1.19.2009 11:30am
Aric (mail) (www):
As I posted on Marginal Revolution this past weekend:

I took out a pair of mortgages about 18 months ago for $210,000, and used them to buy a house for $210,000. I'm not subprime, but I do currently owe about $205,000 on a house that just appraised at $200,000. These securities are probably among the hard-to-value class, but not the worst ones.

Why not sell them back to me? If they're really worthless, then the bank should be happy to sell them to me for, say, a total of $50,000.

I'll believe that banks are really having trouble valuing these mortgages when my monthly statements on my two mortgages include offers to let me pay off the mortgage for somewhat less than the face value of the remaining balance.

It's two mortgages, balances $155k and $50k. What do you suppose the holder of the second mortgage would say if I called them and offered to give them $40k in return for them considering it paid-in-full - including no dings on my credit?
1.19.2009 11:50am
Crunchy Frog:
Aric: Careful! It's not just the credit ding. It's the very real probability that the holder of the second mortgage would immediately turn around and 1099 you for the $10K of "income" they so graciously gave you.

That's the nasty little surprise that the loan modification schemers don't bother to tell you about. Yeah, they get your loans written down, but after they take their cut (which ain't cheap) and you get done paying federal and state taxes on the write-down, there might not be a whole lot of difference.
1.19.2009 12:08pm
David Schwartz (mail):
Aric: Presumably, TARP will be paying them more than what they could currently sell the mortgage for. So why should they sell it to you for X when the government is going to be offering >X?
1.19.2009 12:13pm
Aric (mail) (www):
Crunchy Frog:

I would have no problem paying taxes on the difference. My 'profit' would be $10k, and so the taxes (federal and state) would be about $3300. I still come out $6700 ahead.

If my mortgage holder offered to let me out of my $50k mortgage for $40k, I could probably wrangle up the cash to do so. (Maybe with a new mortgage?) If they're not willing to do that, then I don't want to see the government buying it from them for $25k.
1.19.2009 12:24pm
Anderson (mail):
After all, people don't seem to have much trouble valuing the institutions—the banks, for example—that own them

??? Notice any trace of volatility in the stock market lately? Wild swings? As if there were companies whose real value nobody really knew?
1.19.2009 12:39pm
Dan Simon (mail) (www):
I think you're overthinking this, Eric. I agree that the valuation problem isn't the issue, because the original TARP reverse auction plan was designed to solve that problem, and was scrapped because it was determined that even a successful auction would leave most of the big banks insolvent, once they'd received fair value for their toxic waste.

I infer, then, that the whole point of the new plan is precisely to get the bad assets off the banks' balance sheets, and to inject enough capital into them to keep them afloat. Buying their bad assets at inflated prices kills both birds with one stone. Keeping the government from forking out trillions of taxpayers' dollars to bank shareholders in the process is, it would appear, a non-goal.
1.19.2009 1:00pm
David Drake:
David Schwartz said:


The government didn't break these mortgages. These mortgages are broken because originators made loans to people who couldn't pay them off. The current owners of these securities, who likely bought them at a massive discount from the actual victims, will get a windfall


We're talking about the securities backed by these mortgages, not the mortgages themselves, so in about half the cases, Fannie or Freddie bought the mortgages and issued the securities and therefore are responsible for cleaning up the mess.

Why can't Fan and Fred themselves act as the "aggregator" for the MBS's they issued AND the security for the notes--that is, the original mortgages? They and the U.S.government are on the hook now. It would also make it easier to justify taking a loss on the purchase AND easier to work out the underlying mortgages with the borrowers. So this would kill three birds with one stone.

To address Mr. Schwartz second point, which I believe is a good one, the government should pay no more than the holder paid plus interest. So the price would be lower of face or amount paid plus interest
1.19.2009 1:04pm
Dan Weber (www):
(ii) default has occurred or is reasonably foreseeable

Cool, how do I make it look like it's "reasonably foreseeable" that I will default so I can get a cramdown? I could probably arrange to "lose" my job for a few months in exchange for getting a few tens of thousands of dollars written down on my mortgage.

I'm way in the money on my house, though, having put 25% down, paid aggressively, and even had it appreciate a bit since purchase.

A "homeowner bailout" must absolutely not encourage me to be self-destructive so I can get some of the bailout. To this end, a good cramdown should be something this:

1. Property is occupied by owner since the mortgage was taken out.
2. That mortgage was a purchase mortgage, not a refi. (We can include no-cash-out refi's if we can positively determine that they were no-cash-out.)
3. All payments have been made to date (or else see below).
4. The outstanding balance is crammed down to the value of the property.
5. The mortgage holder gets a certificate for a percentage of the sale value of the home above that new baseline for the next N years. This attaches to the property.

This plan would not (directly) benefit me, which is a good indicator that it's on the right track. But it would help prices move more quickly to their correct values and take a lot of mysteries out of the market.
1.19.2009 1:14pm
NTB24601:
Dan Weber:

Cool, how do I make it look like it's "reasonably foreseeable" that I will default so I can get a cramdown?

Credit cards. Vegas. Enjoy!

I agree with the principle that a "homeowner bailout" must not encourage self-destructive behavior. I'd add that it ought not reward such past behavior. I understand, and agree with what you suggest for #1, 4 &5. I don't understand #2 &3 though.
1.19.2009 1:39pm
NTB24601:
David Drake:

...so in about half the cases, Fannie or Freddie bought the mortgages and issued the securities...

Is this true? You might be correct, but its a claim I'm leery of accepting without a source.

Assuming, it is true: (1) Isn't the problem (or at least a large part of the problem) with these securities the mortgages themselves? (2) Is it truly accurate to equate Fanny Mae and Freddie Mac (at that time) with the U.S. government? (3) What about the other half?


To address Mr. Schwartz second point, which I believe is a good one, the government should pay no more than the holder paid plus interest. So the price would be lower of face or amount paid plus interest

So the holders not only get the windfall of the difference between the current market value and the original face value, they also get interest?

As a taxpayer, I'm pretty sure I object.
1.19.2009 1:48pm
Dan Weber (www):
I understand, and agree with what you suggest for #1, 4 &5. I don't understand #2 & 3 though.

#2 is to stop people from taking all the money out of their house at the bubble, stuffing it into an IRA, and then getting the drop in value paid off.

I realize I left #3 unfinished, but it was to make sure that people can get help without appearing desperate (or else people will purposefully make themselves desperate by missing payments). Any late fees or missed payments would be rolled into the new value of the home. So if they were $3000 behind, and the house was appraised at $250,000, and they owed $300,000, their new mortgage would be $253,000.

The primary determinant of someone walking away from their home (or going through foreclosure) is how much equity they have. If people have $90,000 of equity in the house they will find a way to make the payments work. If they are heavily underwater, there is incentive to walk away even if they would, all else equal, rather stay in that house.
1.19.2009 2:01pm
Laura S.:

The FAS 157 "mark to market" rule means that these very low prices make the MBS's a drag on the balance sheet far beyond whatever real loss in value they may have suffered.

Commercial Banks are not really effected by mark-to-market. They are allowed to classify these securities as held-for-investment. The big Investment Banks did not have this option; thus, they got into a lot of trouble.

Most Commercial Banks are worried about what might happen. i.e., once a mortgage defaults or the terms get rewritten by a government program, they must record a loss. If they wait until the last moment they may consume enough of their capital to become technically insolvent.

Barny Frank has said that loan modifications are "costless", but they are not. They consume capital which is precisely what is in short-supply.
1.19.2009 3:25pm
David Schwartz (mail):
"To address Mr. Schwartz second point, which I believe is a good one, the government should pay no more than the holder paid plus interest. So the price would be lower of face or amount paid plus interest." Right, let's make sure the program helps the very stupidest and most culpable the most.
1.19.2009 6:15pm
Charlie (Colorado) (mail):
I shoulda thought of that years ago, when I was foolish enough to think a business was insolvent when it ran out of money.

Or, when you imagined that a bank was considered insolvent in the same way non-banks are. (Look up "run".)
1.19.2009 8:24pm
Charlie (Colorado) (mail):
Laura, you're right, and note the way the investment banks have been rushing to turn themselves into commercial banks. But that doesn't solve the problem, because it was the investment banks that hold the mortgages against which the MBS's are issued. The commercial banks hold either MBS's which they aren't sure have a value -- and whether they mark to market or not, they're foolish if they assume that doesn't represent a large hazard against which they must risk-manage -- or they hold commercial paper or have commercial deposits in firms which they can no longer evaluate risk. Both of these lead to an inability to make loans, and that's what led to the credit crunch.
1.19.2009 8:30pm
David Schwartz (mail):
Also, I should point out that discriminatory buying schemes don't work anyway. Market forces simply put the item in the hands of whoever can sell it for the most money. The person currently holding it gets about that much, less transaction costs.

If I have a widget and you will buy the widget from Fred for $500, I'll sell the widget to Fred for $480. Your refusal to pay me $500 for the widget only costs me, at most, some additional transaction cost.
1.20.2009 12:34am
gran habano:
No, Charlie, no need to look up "run", or "recession" or "energy shock" or "housing bubble" or about any other influences that might affect a business. Healthy businesses will survive these influences... unhealthy ones will struggle... and that's not "artificial insolvency", but good old fashioned bankruptcy, assuming we get out of the way.
1.20.2009 7:01am
David Drake:
NTB24601--

I did a quick search last summer for Fannie's and Freddie's share of the MBS's and it was about half. In any event, it's billions.

NTB24601 and David Schwartz:

I fail to see why my proposal is a drain on the Treasury that it would otherwise not bear or a windfall for the holders. Fran and Fred with implicit government guarantees issued securities backed by the mortgages. Fan and Fred as the issuers are responsible for paying the securities, regardless of the state of the collateral (unless recourse is solely to the collateral, but I doubt that it is.)

Last summer, the government more or less made the guarantees explicit by taking Fan and Fred over.
Therefore, if Fan and Fred fail to pay, Treasury will ultimately end up liable, if for no other reason than to preserve the credit worthiness of the government.

The claim would be for face value (less principal paid to date) plus unpaid interest. So giving the holders now the lesser of face value (less principal paid to date) or the amount paid plus unpaid interest essentially makes the holders whole while not expending anything more than Fan, Fred and Treasury would have had to pay in any event. Why is that a windfall?

Second, Fannie and Freddie, having originally bought the mortgages and put the various MBS collateral packages together, are in the best position to unbundle those packages, separate the good mortgages from the bad, repackage and resell the good to get cash to continue the process, and then renegotiate terms with mortgagors if feasible or foreclose and deal with the underlying properties ASAP. They can also then bring suit against the mortgage originators if there is any contractual or fraud-type liability.

The non-government half is a much more difficult problem because the Treasury is not on the hook (directly or indirectly). Therefore the fundamental tradoff is between overpaying for assets versus not addressing the capital problems of the holders.

My guess is that the securities are worth more than anyone is likely to pay for them in today's panic-driven market. Default rates on mortgages, while historically high, are still a fraction of mortgages outstanding. That may be one reason why the holders don't want to sell at today's prices.
1.20.2009 9:52am
Ident (mail):
For what it's worth, I tend to think that the issue is one of both pricing and liquidity. Let me give you an example.

FASB recently approved a FASB Staff Proposal that attempts to find some middle ground in the mark to market debate. The proposal converts the impairment models for certain credit instruments, primarily securitized products in this case, from EITF Issue 99-20's "market participant assumptions regarding future cash flows" i.e., market prices, to FASB 115's "Statement 115 does not require exclusive reliance on market participant assumptions regarding future cash flows, permitting the use of reasonable management judgment of the probability that the holder will be unable to collect all amounts due." The change takes effect retroactively, back to December 15th, 2008.

In their comment letters, some banks provided examples of performing assets that they are currently carrying at significantly marked down levels. Wells Fargo provided some good illustrations with respect to a AAA rated CMBS, marked at 30.98 (by JP Morgan) with a yield to maturity of 28%. The loan pool would need to lose 10.5% before this class would lose and there have been no delinquencies to date. With respect to another security they mentioned, the manager launched a discount tender offer for 30% of the debt in November at a price of 55. Nobody sold so they raised the tender to 65 and one small transaction occurred. The yield to maturity was 13% at that level. Wells Fargo is carrying the instrument at 23 (a yield to maturity of 40%) based upon JP Morgan pricing. Wells Fargo explained the situation, "This is a vivid illustration of the magnitude of the liquidity premium and, in fact, incongruent price information being disseminated in the current market. There are no sellers of the security at a price of 65, and yet the price mark that we get from a reputable dealer is 23." One last example is a CLO that would need to incur 30% losses before Wells Fargo's class would incur a loss (less than 1% of assets are in default). It was marked at 22 (Morgan Stanley pricing) with a yield to maturity of 33%. The kicker is that 33% of the assets are in cash.

These anecdotal examples certainly sum up how dysfunctional credit markets are. And it suggests that having a ready buyer providing liquidity for these products would help bring pricing back in-line. Of course, using FASB 115 will help as well. But I believe that the credit markets would trust pricing based upon actual transactions over FASB 115....
1.20.2009 9:55am
David Schwartz (mail):
David Drake: There's a logic flaw in your argument. If Fannie and Freddie are responsible for the monetary payouts for the securities, then why buy the troubled assets and why are they troubled? The full payment is guaranteed by the US government regardless of what happens to the underlying mortgages, why do you even need to buy back the securities to refinance the mortgages?

If I held such a security, why would I care what happens to mortgage? So long as the Federal Government makes my payments, I'd be quite happy.
1.20.2009 2:48pm
David Drake:
David Schwartz: As applied to an individual investor, you're right. If I held any of this paper, I'd just hold it to maturity, figuring that there is a very good chance I'll get paid face value, and because the yields on these are very good compared to other investments.

However, mark-to-market accounting requires holders to value the security at its current "market" value. Because market value depends on factors like the perceived likelihood of Fannie or Freddie to default and the value of the underlying collateral, the holders are writing their assets substantially down, which impacts their capital. To get past this "rough spot" the idea is to have Treasury purchase the securities as "buyer of last resort."

I liked the old rule that distinguished between assets you held as an investment and that you valued at your cost, and those you held as inventory and that you had to value at current market value. The new accounting rule is having a big negative impact today.
1.20.2009 3:59pm
David Schwartz (mail):
I guess I still don't get it. If the payouts are guaranteed by the United States government, there is no reason the assets should be troubled. There should be any number of people willing to pay near-full value for them. That they're troubled and that the market rates are so low is almost irrefutable evidence that people do not believe their performance is guaranteed.

Why not just have the government explicitly guarantee the payouts in exchange for permitting the government to do whatever it wants with the underlying mortgages. I can't see how anyone could turn down such an offer. And if the government is guaranteeing the payments anyway, what's the downside?
1.20.2009 5:22pm
David Drake:
In essence sell the mortgages to the government in exchange for an explicit guaranty on the notes? One problem I see is that it may give the holders a windfall in that government debt these days bears extremely low to zero interest rates while these securities--or at least certain of them--carry a much higher interest rate and it exascerbates (sp?) the problem you originally raised--which I believe is a true problem-- of institutions that bought the securities at large discounts. This would really give them a windfall!
1.21.2009 10:56am
David Schwartz (mail):
David Drake: You can't have it both ways. Either you believe the government guarantees the payout of these securities or you don't. If the government guarantees their payout, then they'll get a windfall no matter what. If the government doesn't offer them the same windfall they'll get from the guaranteed payments, they won't sell.
1.22.2009 1:28am
Isaac Gradman (mail) (www):
In order for loan modifications to truly make sense, they have to achieve for the holders of the loans a greater expected return (in net present value terms) than the expected return from foreclosure. This is usually achieved by lowering the interest rate or extending the term of the loan such that the borrower can still afford to pay, and thereby bring a higher return to the loan holder in the long run than if the property was immediately sold. In the case of Countrywide, a logical settlement would have required Countrywide itself to make up any shortfall to investors as a result of the agreed-upon modifications. If Countrywide was really at fault for predatory lending or poor underwriting (and why would it have settled for over $8 billion if it wasn't?), it should absolutely be required to pay this shortfall under the terms of the settlement agreement. The fact that it isn't is a result of either an oversight of unprecedented proportions on the part of the Attorneys General, or a political ploy to make it look like Countrywide (BofA) is being punished, when really it is being let completely off the hook. You can read more on this issue on my blog at The Subprime Shakeout - Countrywide Settlement.
1.23.2009 8:40pm
David Schwartz (mail):
The high-level aggregators, as I understand it, will claim that they reasonably relied on third-party independent auditors to assure that the loans were kosher and that they're no more responsible for the actions of the non-employee low-level originators than the people who bought the mortgages or aggregated them into securities are.

The problem is that you have a chain with many links, with the fraud at the bottom and the victim at the top. When the wine turns out to be sewage, somewhere in the line you'll find a guy who swears he was told he was buying wine from a guy who swears he said he was selling sewage.
1.24.2009 2:10am
klimmklimm (mail) (www):
Perfect work!
Gluttony kills more men than the sword.
Good health is above wealth

[url=http://buy-xenical-online-klim.blogspot.com/][/url]
9.20.2009 8:19am
petrarka (mail) (www):
Perfect work!
9.24.2009 9:34am
petrarka (mail) (www):
Perfect work!
9.24.2009 9:34am
petrarka (mail) (www):
Perfect work!
9.24.2009 9:34am
petrarka (mail) (www):
Perfect work!
9.24.2009 9:34am

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